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Published July 15, 2026
Yes. The depreciation you took gets taxed back at up to 25% under IRC 1250, even if you do a 1031 exchange.
Yes. When you sell a rental property you have depreciated, the portion of your profit equal to the depreciation you claimed is taxed as unrecaptured Section 1250 gain, at a maximum federal rate of 25 percent, not the lower 0 to 20 percent long term capital gains rates. That tax bill follows you even if you route the rest of the sale through a 1031 exchange, unless you take zero cash or debt relief at closing.
Every year you own a rental, you deduct depreciation against your income. That deduction lowers your tax bill along the way, but it also lowers your cost basis in the property. When you sell, the IRS wants some of that benefit back. Under Internal Revenue Code Section 1250 and the rules in IRS Publication 544, the gain attributable to depreciation you took (or could have taken) on real property is called unrecaptured Section 1250 gain. It is not ordinary income and it is not standard capital gain. It sits in its own bucket, capped at a 25 percent rate.
Say you bought a duplex for $600,000, depreciated $150,000 over the years, and sold it for $900,000. Roughly $150,000 of your $450,000 gain (the amount that mirrors the depreciation you took) is unrecaptured Section 1250 gain, taxed at up to 25 percent. The remaining gain gets the normal 0, 15, or 20 percent federal capital gains treatment depending on your income.
You report the sale on Form 4797, Part III, which walks through the depreciation recapture calculation for real property. The unrecaptured Section 1250 amount then flows to the Unrecaptured Section 1250 Gain Worksheet in the Schedule D instructions, and from there onto Schedule D and your 1040. The 25 percent figure is a ceiling, not a flat tax. If your ordinary income tax bracket for that year is lower than 25 percent, you pay your lower rate on that portion instead. Owners in the top brackets almost always hit the full 25 percent on the recaptured piece.
A fully qualifying like kind exchange under Section 1031, where you roll all of your proceeds into a replacement property with equal or greater value and equal or greater debt, defers both your regular gain and your unrecaptured Section 1250 gain. Nothing is taxed in the year of the exchange.
The trouble starts when an owner takes any boot, meaning cash out at closing, a reduction in mortgage debt that is not replaced, or personal property swapped along with the real estate. Boot triggers recognized gain up to the amount of the boot, and that recognized gain is taxed under the ordinary Section 1250 recapture rules first, before any remaining gain gets standard capital gains treatment. In plain terms: doing a 1031 exchange does not automatically wipe out a depreciation recapture bill. It only defers the recapture on the portion you actually rolled forward.
California conforms to the federal rules for computing gain, including the depreciation recapture concept, through Revenue and Taxation Code section 18151, but the state does not have a preferential capital gains rate at all. The Franchise Tax Board taxes every dollar of gain, including the recaptured portion, as ordinary income at the state's regular marginal rates, up to 13.3 percent once the 1 percent mental health services surcharge on income over $1 million is included. So a South Bay owner selling a long held rental can be looking at up to 25 percent federal on the recaptured slice, standard federal capital gains rates on the rest, and up to 13.3 percent California tax stacked on top of all of it.
If you have owned a rental for a decade or more and claimed depreciation every year, assume a meaningful chunk of your sale proceeds is already earmarked for the IRS before you list the property. Before you sign a listing agreement, ask your CPA to run the actual numbers, factoring in your specific accumulated depreciation, not a rule of thumb. If a 1031 exchange is on the table, get clear on exactly how much boot you plan to take, because that number drives how much recapture tax hits this year versus later.
If you would rather have someone track your basis and depreciation schedule accurately from year one instead of reconstructing it at sale time, that is part of what we do for owners at Schofield.
This is general information, not legal or tax advice. Confirm with a licensed professional before you act.
Last verified: July 2026.
Topics: taxes, depreciation recapture, 1031 exchange, capital gains, rental property sale
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Schofield Properties is a family run property management company at 323 Richmond St, El Segundo, CA 90245. We have managed the South Bay since 1972 and personally oversee about 186 doors today. Book a call to talk about your property.
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